EU carbon market and floor prices

The European Union’s Emissions Trading System (EU ETS), often referred to as Europe’s flagship tool to fight climate change was established in 2005 and includes over 11.000 installations across the European Economic Area, covering around 40% of Europe’s greenhouse gas (GHG) emissions. The EU ETS is a “cap and trade” system, meaning that a cap determines the total amount of greenhouse gases that companies can emit. Under the annually shrinking cap, companies receive or buy emission allowances which they can trade as needed.

Since the beginning, the EU ETS has suffered from a surplus of emission allowances which has led to a price too low to spur a climate friendly transformation. The main causes for the insufficient price signal are an unambitious overall target, the economic crisis that started in 2008, and the inflow of international credits.

The situation is likely to improve in the future as with a reform that will remove surplus emission permits from the market. However, this reduction of the surplus will be incremental, and occur too slowly and too late to wipe out all the excess permits in the next years. As it stands, the EU carbon price will not be high enough to make fossil fuels financially unattractive, a crucial step towards limiting global warming.

A carbon floor price, reflecting the true cost of pollution on society either at the regional or European level would help solve the problem of too low prices and bring investment certainty.

Carbon Market Watch advocates for regular reviews of the EU ETS to bring it in line with staying below 1.5C warming, as agreed in the Paris climate agreement. We moreover call for a phase-out of the free allocation of pollution permits to industry players, who have made over 25 billion euros windfall profits from the EU ETS in the past. The revenues generated by the carbon price should flow back to the most vulnerable groups that are negatively affected either by climate change or the policies to fight it.